There are mixed signals as to whether or not the economy will soon enter recessionary territory, but the odds appear to be rising with every week that passes. The stock market seems to be screaming “yes,” but economic statistics are saying, “Whoa, not so fast.” The difference is that the stock market looks forward about six to nine months while economic stats reflect the past.
Retail sales increased for four straight months through April, though they took a step back in May. Likewise, industrial production has risen for four straight months. The Purchasing Managers Index reflects activity in the manufacturing and service sectors, and remains strong in both the U.S. and Europe, although it is down slightly from recent months. Yet, confidence surveys of consumers and small businesses are in the tank.
We typically follow the consumer when looking for signs of a recession. The trend of rising retail sales suggests economic strength rather than weakness. However, the signs may not be as they first appear. Much of the surge in retail sales is due to higher prices, though some of these sales occurred before the recent spike in food and energy prices. Lastly, consumer spending has been rising faster than average incomes, suggesting consumers are dipping into savings to maintain their lifestyles.
Comments from major retailers provide anecdotal evidence that higher food and energy prices are starting to influence consumer behavior. It may be that these current comments are ahead of government statistics which are reported monthly and take time to be collected. In this environment where supply chain issues have resulted in shortages of many products, it is noteworthy that Walmart and Target are complaining of excess inventories, particularly of clothing and furniture.
There appears to be no letup in inflation. The Consumer Price Index (CPI) rose an astonishing 8.6% over the past 12 months through May. If there is any consolation to be found in the report, the so-called “core” CPI gained 6.0%, a slight slowdown from the 6.2% rise through April. The difference between these inflation measures reflects the impact of surging energy and food prices, both of which are excluded from the “core” index. This exclusion is fair when temporary factors like weather cause fluctuations in food and energy prices, but they are a very real (and growing) part of household budgets.
Stock market action implies that recent Fed rate hikes may lead to a recession, likely sometime in the next year. We don’t say this as economists, but as watchers of investor behavior. The S&P 500 and Nasdaq are well into bear market territory, defined as a decline of 20% or more from the previous peak. The Dow is not there yet. A bear market is more than just an arbitrary number, however; it is a state of mind. Investors have been exhibiting bear market behavior over the past month or two. In a normal market, favorable company developments are rewarded with higher stock prices; bad news causes prices to decline. In a bear market, investors are inclined to take only one action: sell. Bad news brings about the expected decline, perhaps worse than in a normal market. However, in a bear market even good news is frequently met with yawns rather than cheers.
If we are indeed in a bear market foreshadowing a recession, what can investors expect? The median decline over the past 80 years has been 28%. The span of the typical bear market runs almost a year. At a recent decline of 22% from its January 4, 2022 peak, the S&P is approaching the depth of a typical bear market, but difficult conditions may persist for most of the year if history is any guide. Typically, the market bottoms out in the early part of a recession, so a recession beginning this autumn would fit the pattern. There will likely be false starts along the way that might make investors believe the worst is over, only to be met with renewed selling. Eventually, the sellers run out of shares to sell, and the buyers/holders are all that remain. That’s when the market turns around. However, no bells go off to signal the end of the bear market and the beginning of the next bull market. It will likely come at an unexpected time when economic news remains bad.
In the meantime, there are opportunities to position portfolios for success in the inevitable upswing by trading up to even better companies, such as the large software company, automobile seller, and industrial tools manufacturer profiled in the July 2022 issue of the Investor Advisory Service stock newsletter.
As the old saying goes, frequently attributed to banker J.P. Morgan, “In a bear market, stocks are returned to their rightful owners.” The coming months won’t be easy, but let’s remember that those “rightful owners” are all of us.
Reprinted from the July 2022 issue of the Investor Advisory Service stock newsletter, rated #1 for performance in 2021 by Hulbert Ratings.
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